Why does Goldman Sachs favor A-1 despite wider spreads?

  • AAA spreads on non-QM residential mortgage-backed securities (RMBS) have widened from approximately 125–130 basis points in July 2026 to 155–160 basis points. Investors are concerned about longer repayment periods and issuers' lack of incentive to redeem deals early.
  • They also lagged the tightening of agency MBS spreads in October, widening their spread advantage over agency MBS to 25–30 basis points, near the wider end of the historical range. Goldman Sachs considers the price compensation more attractive, and recent structural changes in new deals have strengthened protection for A-1; it therefore maintains its preference for higher-quality tranches.

How does repaying A-1 principal first reduce extension risk and encourage redemption?

  • Recent deals have replaced pro rata principal repayment among senior tranches with a strictly sequential structure: all distributable principal first repays A-1, followed by A-2 and A-3 only after it is paid off. A-1 therefore receives its principal earlier and faces less exposure to extension.
  • A-1 is both the largest tranche and the one with the lowest interest rate. Paying off this inexpensive financing first raises the average cost of the remaining debt more quickly, strengthening the issuer's economic incentive to redeem the deal before the coupon step-up.
  • The protection has a clear cost: A-2 and A-3 must wait longer to receive principal. Under Goldman Sachs' four-year redemption scenario, the weighted average lives of both tranches could extend to four years; if the deal is not redeemed, the extension would be more pronounced.

With a thinner financing cushion, where does the money for the senior-tranche coupon step-up come from?

  • If a non-QM deal remains unredeemed after 48 months, senior-tranche coupons step up by 100 basis points. But in Goldman Sachs' sample, the cushion between underlying mortgage coupons and financing costs fell from more than 120 basis points in July to approximately 50–75 basis points in early October, making the step-up harder to cover with existing cash flows alone.
  • Traditional structures can divert interest from the B-3 tranche to make up the shortfall; new structures also draw on B-2, and some even draw on B-1. In certain deals, these subordinate tranches stop accruing interest after 48 months and retain only the right to principal repayment, effectively directing more interest cash flow to the senior tranches.
  • Goldman Sachs believes that, with B-2 interest included, the senior-tranche step-up can be covered under most reasonable prepayment and default scenarios, but protection differs by tranche: even if both prepayments and defaults are zero, A-1 is still expected to receive the full step-up, while A-3 may not.

What conditions constrain this relative-value assessment?

  • Protection under the new structure is concentrated in A-1 and cannot be extended to every AAA tranche in a deal. Goldman Sachs believes a severe housing downturn accompanied by low prepayments and high defaults could still leave A-1 short of interest; this is not the firm's base case for the next few years.
  • The interest-coverage calculation uses CROSS 2026-NQM12 as its sample. The deal permits the diversion of B-2 interest, and the calculation assumes a loss severity of 40% on defaults. The interest-diversion terms of each deal determine whether the protection described above applies.
  • The recent decline in Treasury yields helps ease concerns about extension and redemption; deals issued early in the year are more affected by those concerns. Goldman Sachs' view therefore favors newly issued A-1 tranches with stronger structural protection, rather than existing non-QM securities indiscriminately.